Tag Archive | "diversiifcation"

More ETF Risk


There are pros and cons to investing in ETFs.

After almost 50 years of tracking global investments and currencies, I was fed up with the process of finding good investments.  I had made some small fortunes, yes.  And I had some disasters too, but I was pretty good at it.  I was pretty good at the process.  Investors all around the world depended on my decisions.  I had even managed a portfolio of millions for a European bank.

Some facts, however, had become clear.  First, I realized I was spending too much of my time sitting in front of a computer analyzing numbers.  Second, the process was no longer fulfilling, satisfying or fun. Third, the process took a lot of time.

When those who reach 70, time becomes more valuable.  At least that is how it seems.

I started looking for a better way to look after my savings and wealth and came to the conclusion that investing in Country ETFs in stock markets that were undervalued gave me as good a chance of making profit as anything, but took far less time and cost much less in fees.

That’s when I created the Purposeful investing Course (Pi).  I approached three colleagues, who were brilliant mathematicians and equity and market analysts.  They had passed the test of time and proven their investing skills.  I asked them for help putting together a course that would help me and others gain diversification and extra profit potential without spending too much time in the process.

The course is built around the idea that Country ETFs can be the core of a portfolio because they offer an easy way to diversify in good value markets.  Little management and less guesswork is required.  The expense ratios for most ETFs is lower than those of the average mutual funds.  Plus a single country ETF provides diversification equal to investing in dozens, even hundreds of shares.

We have had good response to this course but recently a Pi subscriber sent this note.

There is a potential ETF risk and a subscriber of Pi sent this question.

“Gary, Here’s another newsletter which may be of interest.  The author has recently been writing about his concern regarding ETF’s and “passive investing”.  Would be interested to hear your thoughts.”

That other newsletter said.  “When ETFs sell, who will buy?”  The ETFs of the world may quickly begin trading below their actual net asset values (NAV).  This is called price discovery, and the arbitrageurs will not be slow to take advantage of that difference.  This means the indexes will drop much faster than they have gone up.

Here is my reply:  First, we should look at a slightly bigger picture.  All mutual funds face a couple of problems in collapsing markets.  In fact, regular mutual funds have more problems than ETFs.

The first problem is liquidity.  Typical mutual funds must redeem shares from their own cash reserves or the sale of investments.  If a market crashes and a mutual fund is hit with overwhelming redemptions, they either have adequate cash, must borrow to redeem or must sell shares.   If a manager is any good, he or she will normally not want to sell assets during a panic crash.  Market dips are the time when value investors buy not sell!

In other words, a normal mutual fund’s ability to invest may be inhibited at the very time it’s best to buy.

ETFs are not open ended funds so they do not have to redeem shares during bad times.  The shares are bought and sold on the stock market.  This means that ETFs normally have greater liquidity than normal mutual funds in the most difficult times.  They can be sold anytime the market is working.  Plus the fund managers have more ability to invest in bad times because they simply track the related index, whether it is falling or not.

ETFs, like all shares sold on a market, are likely to drop in a market collapse, especially if the correction is systemic.

However, I personally stick to ETFs as my equity of choice because they are so easy and so diversified.  This allows me to spend my time doing other things I enjoy to have a more fulfilled life.

My experience of investing from London many decades ago, suggests that the theory behind this ETF problem does not prove out in reality.

Long before the words ETF or the idea ETF were even thought, the English have had Closed-end Mutual Funds (called unit trusts).  These funds are remarkably similar to ETFs as they have a fixed number of issued shares traded on an exchange.  They generally do not issue new shares after the close of the subscription period.

Because the supply of shares is limited, the traded price of the closed-end fund will rise and fall depending on supply and demand, just like shares of other companies traded on an exchange.  Closed-end funds often trade at a discount to their Net Asset Value.  Other times they trade at a premium.

Value investors look for these trusts that trade at a discount.  Warren Buffet explained the reason when he compared the difference in a market’s reaction to what consumers do when McDonalds lowers the price of its burgers.  Consumers buy more good value burgers.  Yet when stock markets lower the price of  good shares, the market panics and sells.

Here is what almost always happens when closed end unit trusts sell at too great a discount.  Value investors step in and buy the closed ended fund, either in recognition of the extra value or to wind it up and sell the assets for a profit.

The question we should ask is not whether ETFs will remain stable in difficult times.  No share remains immune to crashing prices if a market is fearful enough.

The more important question is how do we regulate our investments so we are liquid enough to invest, not sell, when markets are down.  If we have prepared our positions correctly the question of getting a good price during a downturn never comes up because we will be buying, not selling.

The best time to invest is when shares or a market are in trouble.  Here are some quotes by Warren Buffet that address this issue:

“The best time to buy a company is when it’s in trouble. – The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”

“Be greedy when others are fearful.  – Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”

“Stocks have always come out of crises. – Over the long term, the stock market news will be good.  In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”

We should be aware of the pros and cons of our investments, but it is more important to create resilience in our portfolios and investing habits so we can hang on and even increase positions in down times.

If we have good value shares, the only time to sell is when we find better investments or need cash.

If you are spending too much of your time sitting in front of a computer and the process is no longer fulfilling, satisfying or fun, I recommend that you read below how to save time as you increase the safety of your investments as expand profit potential at the same time.

Gary